No D&O Coverage for Payment to Shareholder Class; Parties Fight Over Access to D&O Proceeds

Directors and officers insurance policies are full of holes
and do not provide coverage for many basic corporate exposures. The
Genzyme case discussed below demonstrates the prevalence of the
insurers' defense that many settlement payments do not constitute
"loss" under the D&O policy but rather are restitutionary
payments that are not covered.

Summary

On September 28, 2009, the United States District Court for
the District of Massachusetts dismissed a lawsuit filed by Genzyme
Corporation ("Genzyme") seeking insurance coverage from Federal
Insurance Company (the "Insurer") under its D&O insurance
policy (the "Policy") for a settlement of a shareholder class action. See
Genzyme Corp. v. Federal Ins. Co., 2009 WL 3101025, civ.
Action no. 08cv10988-NG (D. Mass. Sept. 28, 2009). In determining that
there was no insurance coverage for the settlement, the Court relied
primarily upon the definition of "loss" in the Policy and a "Bump- Up
exclusion" in the Policy, which relieved the insurer of liability for
any "inadequate or excessive consideration in connection with [the]
purchase of securities."

Background of Underlying Claim

Genzyme is a biotechnology company. It had sold a series of
"tracking stock" designed to track the performance of certain business
divisions of the company. From December 2000 through June 2003, three
series of Genzyme tracking stock were outstanding; specifically, the
Biosurgery, Molecular Oncology and General Divisions. On May 8, 2003,
Genzyme announced that it was going to exercise the optional exchange
provisions in its Articles of Organization, which would effectively
eliminate the corporation's tracking stocks by exchanging all
outstanding Biosurgery Division and Molecular Oncology Division shares
for common stock in the General Division. Shareholders holding stock in
the Biosurgery and Molecular Oncology Divisions were compensated as
part of this share exchange based upon the current market value of
their stock as compared to the value of the common stock of the
company.

A number of shareholder lawsuits were filed against Genzyme
and its officers and directors as a result of this share exchange, and
these shareholders were certified as a class on August 6, 2007. While
the complaint contained seven counts, it primarily alleged that Genzyme
and its officers and directors conspired to depress the market value of
outstanding Biosurgery Division stock in order to exchange it for
common stock at a rate that would result in a profit for the General
Division shareholders - including Genzyme's top officers and directors
- at the expense of Biosurgery Division shareholders. Genzyme agreed to
settle the class claims by making a one-time payment of $64 million.

Insurance Coverage Dispute

Genzyme sued the Insurer for coverage under its D&O
Policy. The Court determined that Genzyme did not have coverage for the
settlement payment as a result of two key terms in the Policy - an
exclusion from the definition of a covered "loss" for "matters
uninsurable under the law" and a "Bump-Up" exclusion [1] which
provided, in pertinent part, that:

[The Insurer] shall not be
liable . for that part of Loss. which is based upon, arising from, or
in consequence of the actual or proposed payment by any Insured
Organization of allegedly inadequate or excessive consideration in
connection with its purchase of securities issued by any Insured
Organization.

As an initial matter, the Court determined that the settlement
payment was uninsurable under Massachusetts law for reasons of public
policy. The Insurer cited abundant case law supporting the notion that
an insured does not incur an insurable "loss" when he is merely forced
to disgorge money or other property to which he is not entitled (i.e.,
an "ill-gotten gain"). See, e.g., Level 3 Communications,
Inc. v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001).
Genzyme argued that the settlement payment was not restitutionary in
nature since the company did not receive any benefit from the share
exchange.

The Court sided with the Insurer, stating that while the
company itself did not profit from the transaction, it did effectively
benefit one class of shareholders at the expense of another class of
shareholders, and the settlement was designed to redress this
imbalance. The Court was concerned that requiring coverage under these
circumstances would transform insurance policies into "profit centers"
for companies, stating "[e]veryone would win, except for the insurance
company forced to bear the loss of paying off the disgruntled
shareholders." See decision at *8.

The Court then turned to the Bump-Up exclusion in the Policy.
Genzyme argued that the share exchange did not involve an actual
"purchase" of securities since it was a share exchange and therefore
the exclusion was inapplicable. The Court relied upon the dictionary
definition of "purchase" which includes an exchange for something of
equivalent value, and found that the share exchange was in fact a
"purchase" as that term was used in the Policy. Accordingly, the Court
held that the exclusion was an absolute bar to coverage under Insuring
Clause 3 - coverage for securities claims brought against the entity.

Genzyme further argued that even if it was barred from
recovering for securities claims brought against it as a result of the
Bump-Up exclusion, it was still entitled to reimbursement for the money
it paid to indemnify its directors and officers, since the settlement
was a global resolution of the claims in the underlying lawsuit. The
Court disagreed, stating that no court has "split the baby" in this
manner where coverage for claims against the entity were barred, since
companies can only act through their directors and officers. Moreover,
the Court was concerned that permitting this type of distinction with
regard to a global settlement would permit companies to structure
settlements in a manner to maximize coverage under the indemnification
provisions of a D&O policy where the payment was in fact
restitutionary in nature.

Conclusion

This decision to deny coverage for settlement payments made to
shareholders was largely driven by public policy concerns. The Court
was very keenly attuned to the risk that providing coverage for these
types of shareholder settlements would encourage fraud and chicanery by
insured corporations. The decision also has far-reaching impact beyond
D&O policies containing a bumpup exclusion since the Court
relied upon the disgorgement/ restitution exclusion as an independent
basis for barring coverage. In doing that, the Court expanded that
exclusion to include a stock redistribution or recalibration. This was
a novel analysis of an exclusion found in nearly every D&O
policy and may give insurers ammunition to go farther afield in their
denials of coverage on the basis of this exclusion, in situations
where, as in Genzyme, the company itself did not profit from the
underlying transaction. Accordingly, insureds may need to argue that
the judge's creative recalibration analysis is restricted to the
specific and unusual circumstances of the Genzyme
case and should not be broadly applied.

Whose Money is it?

A trio of recent cases involve who has access to D&O
insurance proceeds; the claimants include companies, their directors
and officers, bankruptcy trustees, receivers, and bankruptcy
plaintiffs.

In Executive Risk vs. Speltz & Weiss, LLC (N.D.Ill.
Oct. 16 2009), Executive Risk had a D&O policy with a
$2,000,000 policy limit. Executive Risk concluded that the attorneys
fees of the various companies and individuals claiming under the policy
would exceed $2,000,000. As a result, Executive Risk successfully
interpleaded in the underlying litigation and placed its $2,000,000
with the court, who would allocate the money among the claimants.

In In re Colonial BancGroup (Bank. Ct. M.D.
Alabama Oct. 9 2009),the plaintiffs in the underlying securities claim
and the receiver asked the court to put limits on the company's
principals' ability to access the $15,000,000 D&O policy.

In SEC v Stanford Int'l Bank (N.D. Texas
Oct. 9 2009), the receiver unsuccessfully asserted that the D&O
proceeds should be subject to the order freezing the Defendants'
assets. The court based its decision on the hypothetical need by the
receiver for the proceeds versus the current need by the insureds.

Most companies do not have enough D&O coverage to
satisfy the defense costs of all of the insured entities, directors and
officers in a major litigation. Corporations should re-examine the
adequacy of the policy limits that they purchase and explore such
mechanisms as Side A coverage and priority of payment provisions to
maximize the protection of the directors and officers.

Robert (Bob) D. Chesler, Chair of the Insurance Practice
Group, is known to his colleagues as "the insurance guru." He
represents policyholders in a broad variety of coverage claims against
their insurers and advises companies with respect to their insurance
programs; he has never represented an insurance company. He is a
relentless advocate for his clients in their efforts to obtain coverage
from their insurers. Few can match Bob's total immersion in insurance
coverage law. He was a leading participant in the birth of modern
insurance law in the early 1980s, when environmental and asbestos
liability unleashed a new world of strict, joint and several, and
retroactive liabilities on corporate America. Bob continues to
successfully navigate the firestorms of coverage litigation that
inevitably ensue when corporations try to pass covered liabilities to
their insurance companies. He has also emerged as a leader in such new
areas of insurance coverage as cyber-insurance, D&O, IP,
privacy and "green" insurance.

Bob's greatest assets are his knowledge and experience. He has spent
his entire career obtaining settlements from insurance companies. He
can speak "insurancese" as well as the insurers, and knows how to
approach insurance companies, when to talk to them and when to
litigate. His depth of experience enables him to distinguish a bad
insurance claim from a good one, and understand and implement best
strategies for obtaining money for his clients quickly and
cost-effectively.

Cindy Tzvi Sonenblick is Counsel to the firm's Litigation
Department and a member of the Insurance Law Practice Group. Ms.
Sonenblick is listed in the 2006 and 2007 editions of The
Best Lawyers in America for her work in insurance law.
Cindy utilizes her insurance expertise in a wide variety of counseling
and litigation matters. Among Cindy's representative matters, Cindy is
currently assisting a large furniture company whose subsidiary is in
bankruptcy navigate its D&O insurance coverage for the benefit
of the subsidiary's directors and officers.

Prior to rejoining Lowenstein Sandler, Ms. Sonenblick was Division
Counsel for AIG Small Business (2006-2007), where she acted as a senior
legal advisor for the small business underwriting division. While at
AIG, she provided advice and developed strategies to assist the
division in complying with state laws and regulations relating to
underwriting, renewals, cancellations, marketing, and rate plans.

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[1]
According to the Insurer, this exclusion is apparently referred to in
the insurance industry as a "bump-up" exclusion because it is used to
describe litigation
seeking to increase or "bump-up" the consideration paid for security.